Wednesday, January 29, 2014

Economics Too Hard For Kartik Athreya

I have been trying to read Kartik Athreya's Big Ideas in Macroeconomics: A Nontechnical View. I find it quite dry. So far, it is all theory. (I guess some might quibble with that, given the overview of results from experimental economics.) There is no history of ideas and no context suggesting that those who might have developed these ideas were any more than disembodied consciousnesses. And no hint is given that whole groups of economists would find these views controversial. (Caveat: he does mention, for example, Ariel Rubinstein and Ricardo Caballero.) For Athreya, Paul Davidson, Wynne Godley, Alan Kirman, and Lance Taylor, for example, just do not exist.

I think Athreya might have misjudged his audience. He says that he is attempting to target two audiences:

  • Advanced undergraduates considering graduate school and beginning graduate students.
  • Popular readers with an interest in macroeconomics.

But the lack of any leavening from a presentation of details of theory will make this book a hard sell for the second audience. Maybe my opinion will change as I read further.

But I want to point out a display of ignorance of the logic of prices in general equilibrium:

"...notice there are likely to be many types of laborers involved in the production of barstools... Thers are also many possible input materials, and different possible production processes. Importantly, the myriad ways in which various inputs can be substituted for each other in barstool production is knowledge that can only be acquired through experience in the field.

In our W[alrasian] C[learing]H[ouse], each furniture maker will, at various prices, carefully consider all the ways in which inputs can be substituted for each other. If, for example, walnut is particularly expensive relative to oak, and oak can easily be substituted for walnut because it won't also necessitate the use of harder-tipped and more expensive saw blades, for instance, the oak will be used. In this way, the experience and almost-inevitably accumulated wisdom of those who have specialized in the production of any given product are brought to bear fully in the industry's use of inputs even though no firms are assumed to communicate with any others within the industry..." [emphasis in original]

As I pointed out many times, prices are not indices of relative scarcity, and neoclassical economists, such as Christopher Bliss, Frank Hahn, and Paul Samuelson have noted the logic of general equilibrium is not that of substitution. (Andreu Mas-Colell has an accessible overview of capital theory.) When will (some) mainstream economists accept their own logic?

Monday, January 27, 2014

Impact Of Piero Sraffa On Industrial Organization

1.0 Introduction

Piero Sraffa, with his 1926 Economic Journal article on the laws of returns, had a great impact on the emerging field of Industrial Organization (I/O). For the purposes of this post, Sraffa's paper can be said to have made two major contributions:

  1. An internal critique of Marshall's theory of partial equilibrium, showing it holds only under the most specious conditions.
  2. Suggestions for how to analyze the wide range of markets between perfect competition and monopoly.

The first contribution is still relevant today, given how the theory of the perfectly competitive firm is still presented in introductory textbooks. One might also argue that how the theories of imperfect and monopolistic competition were developed, they still are vulnerable to Sraffa's critique. In this post, however, I concentrate on a broad historical overview focused on the second contribution above. But Cameron Murray shows that some still find Sraffa's 1920s work of importance for contemporary theorizing about the theory of the firm.

I apologize for lacking references to recent secondary literature. I do not think that the thesis of this post is not well known among historians of economics or the authors of secondary literature.

2.0 Selected Quotes

Sraffa articulated the need for and possibility of theories of market forms between monopoly and perfect competition:

"...when we are supplied with theories in respect to the two extreme cases of monopoly and competition as part of the equipment required in order to undertake the study of the actual conditions in the different industries, we are warned that these generally do not fit exactly one or other of the categories, but will be found scattered along the intermediate zone, and that the nature of an industry will approximate more closely to the monopolist or the competitive system according to its particular circumstances, such as whether the number of autonomous undertakings in it is larger or smaller, or whether or not they are bound together by partial agreements, etc. We are thus led to believe that when production is in the hands of a large number of concerns entirely independent of one another as regards control, the conclusions proper to competition may be applied even if the market in which the goods are exchanged is not absolutely perfect, for its imperfections are in general constituted by frictions which may simply retard or slightly modify the effects of the active forces of competition, but which the latter ultimately succeed in substantially overcoming. This view appears to be fundamentally inadmissible. Many of the obstacles which break up that unity of the market which is the essential condition of competition are not of the nature of 'frictions,' but are themselves active forces which produce permanent and even cumulative effects. They are frequently, moreover, endowed with sufficient stability to enable them to be made the subject of analysis based on statical assumptions." -- p. 542

He stated some basic ideas developed in the theory of monopolistic competition:

"The causes of the preference shown by any group of buyers for a particular firm are of the most diverse nature, and may range from long custom, personal acquaintance, confidence in the quality of the product, proximity, knowledge of particular requirements and the possibility of obtaining credit, to the reputation of a trade-mark, or sign, or a name with high traditions, or to such special features of modelling or design in the product as-without constituting it a distinct commodity intended for the satisfaction of particular needs-have for their principal purpose that of distinguishing it from the products of other firms.

What these and the many other possible reasons for preference have in common is that they are expressed in a willingness (which may frequently be dictated by necessity) on the part of the group of buyers who constitute a firm's clientele to pay, if necessary, something extra in order to obtain the goods from a particular firm rather than from any other." -- p. 544

He described what could be seen as a forerunner of the theroy of kinked demand curves:

"...the forces which impel producers to raise prices are much more effective than those which impel them to reduce them; and this not merely owing to the fear which every seller has of spoiling his market, but mainly because an increase of profit secured by means of a cut in price is obtained at the cost of the competing firms, and consequently it impels them to take such defensive action as may jeopardise the greater profits secured; whereas an increase of profit obtained by means of a rise in prices not only does not injure competitors but brings them a positive gain, and it may therefore be regarded as having been more durably acquired. An undertaking, therefore, when confronted with the dual possibility of increasing its profits by raising its selling prices, or by reducing them, will generally adopt the first alternative unless the additional profits expected from the second are considerably greater." -- p. 548

Sraffa is also a forerunner of the theory of contestable markets, in which one analyzes the effects on existing firms of potential entrants into their markets.

"It should be noted that in the foregoing the disturbing influence exercised by the competition of new firms attracted to an industry the conditions of which permit of high monopolist profits has been neglected. This appeared justified, in the first place because the entrance of new-comers is frequently hindered by the heavy expenses necessary for setting up a connection in a trade in which the existing firms have an established goodwill - expenses which may often exceed the capital value of the profits obtainable; in the second place, this element can acquire importance only when the monopoly profits in a trade are considerably above the normal level of profits in the trade in general, which, however, does not prevent the prices from being determined up to that point in the manner which has been indicated."-- p. 549

I suppose I could also quote Sraffa's suggestion that developments along some of these lines would lead to models with determinate solutions. To summarize, you can see in this paper an outline of a program for the I/O field.

3.0 Impact on Economists Developing I/O

Sraffa was not a voice crying in the wilderness, ignored by economists of his day and thereafter. His paper was one contribution, among many in the 1920s, attempting to articulate the logical requirements for a theory of perfect competition. Sraffa was not even alone in expressing skepticism that one could confidently connect Marshall's theory to the empirical facts. I think of, for example, what has come to be known as the "empty economic boxes" debate.

Edward Chamberlin and Joan Robinson, with their 1933 books on, respectively, monopolistic and imperfect competition, is an example of simultaneous discovery in I/O. Richard Kahn provided Robinson quite a bit of help with her book and was also working on the theory of imperfect competition, if I recall correctly, in his thesis. Kahn and Robinson were directly inspired by Sraffa and interacted with him in Cambridge.

Joe S. Bain and Paolo Sylos Labini provide a later example of simultaneous discovery in I/O. They develop what has become known as "old" I/O, as opposed to more game-theoretic approaches. Sylos Labini, at least, thought of himself as following a Sraffian tradition inasmuch as he was attempting to develop I/O in keeping with a revival of classical political economy. But this observation takes me into Sraffa's later work and beyond the scope of this post.

  • Franco Modigliani (1958). New Developments on the Oligopoly Front, Journal of Political Economy, V. 66, no. 3 (Jun.): pp. 215-232.
  • Piero Sraffa (1926). The Laws of Returns under Competitive Conditions, Economic Journal, V. 36, no. 144 (Dec.): pp. 535-550.
  • Paolo Sylos Labini (1995). Why the interpretation of the Cobb-Douglas production function must be radically changed, Structural Change and Economic Dynamics, V. 6, no. 4 (Dec.): pp. 485-504.

Monday, January 13, 2014

Dennis Robertson's "Wage Grumbles"

To simplify, the factors of production are land, labor, and capital. The marginal productivity of labor is the extra output produced by an infinitesimal increase in labor, holding the quantity of all other factors constant. What does it mean to hold the quantity of capital constant? Dennis Robertson thought about this:

"If ten men are to be set to dig a hole instead of nine, they will be furnished with ten cheaper spades instead of nine more expensive ones; or perhaps if there is no room for him to dig comfortably, the tenth man will be furnished with a bucket and sent to fetch beer for the other nine." -- Dennis Robertson (1931).

I do not know that I have ever read Robertson. But I have seen the above passage often quoted (e.g., in Miller 2000) or alluded to (e.g. in Harcourt 2014).

Anyways, here we see, in a micro-economic context, a constant quantity of capital, measured in numeraire units, with a variable form. The Cambridge Capital Controversy showed this notion to be untenable. And this quote is another demonstration that the CCC was about more than macroeconomic models with aggregate production functions, such as the Solow model of economic growth. We also see that, once, some did not find odd the idea of beer breaks.

  • G. C. Harcourt (2014). Cambridge-Style Criticism of the Marginal Productivity Theory of Distribution, Proceedings of the American Economic Association. Philadelphia, PA (3-5 January).
  • Richard A. Miller (2000). Ten Cheaper Spades: Production Theory and Cost Curves in the Short Run, Journal of Economic Education (Spring): pp. 119-130.
  • Dennis W. Robertson (1931). Wage-grumbles, Economic Fragments. [I DON'T KNOW THAT I EVER READ THIS.]

Saturday, January 11, 2014

Economics And Physics: A Disanalogy

John Scalzi's Cat Looks At A Hugo Award

Suppose you criticize current neoclassical teaching in introductory microeconomics. A defender might reply that it is common to teach incorrect models in introductory classes. Only when the students have that background can they go on to the more sophisticated teaching. For example, physicists teach Newtonian mechanics. They do not start with quantum dynamics and the special and general theories of relativity.

I doubt this defense. Physics can roughly state the domain of applicability of Newtonian physics - medium size dry goods. Physicists have had empirical success within that domain to an astonishing degree of precision. I doubt economists can point to a success where they can notice tiny variations from their predictions analogous to the deviation of the perihelion of the orbit of Mercury of 43 seconds of arc per century or the deflection of the location of stars observed during a solar eclipse. But I do not want to argue about the relative empirical success of simplified theories in economics and physics.

Rather, I want to point out a large difference in the status of such introductory theories in popular culture. A large body of literature exists, popular among schoolchildren and others, pointing out the limitations of Newtonian mechanics. I refer to Science Fiction. The speed limit imposed by the speed of light, for example, is a common trope in SF. It is true that some authors do not hold to it. But they often insist that when their characters violate the constraints of the theory, they utter some jargon: "tachyon nexus", "wormhole", "space warp". Furthermore, SF authors tell many stories where these limits play out, for example, with generation ships that may accelerate and decelerate and in which the crew are quite aware of the difference between their slowed-down local time and the time of the folks back on planet earth. I think that SF back in the forties and fifties may have been more prone to contain lectures about these matters. Nevertheless, I think many students of introductory physics are aware that the truths of Newtonian theory, which they can see played out in the laboratory, do not extend to all of the universe of physics.

I suggest even if you can find accounts in popular culture of, say, implications of game theory inconsistent with introductory microeconomics teaching, you cannot find something as popular and pervasive for economics as SF is for physics. The culture resists somebody preaching physics 101 as an explanation for everything physical.

Monday, January 06, 2014

Noah Smith Tells Us Academic Economists Are (Mostly) Ignoramuses

Noah Smith writes, "...An audience of academics wouldn't know an Austrian from a Post-Keynesian." So he creates a presentation organized around the pettiness and cronyism of economists. (His post from last year had some problems. For example, he cannot tell the difference between a Marxist and an anarchist.) If Noah wanted, he could have attended a session in which Geoff Harcourt introduced him to some Post Keynesian ideas. But maybe such knowledge would be of no help to his career.

Wednesday, January 01, 2014

Updated Paper: "On the Loss From Trade"

I have updated my paper, On the Loss From Trade, available for download from the Social Science Research Network (SSRN). Changes include:

  • Correction of a mistake in calculating price Wicksell effects.
  • Improvement in the modeling of utility-maximization so as to rationalize specific values of the interest rates on Neoclassical premises.
  • Expanded literature review, just so the reader knows that, for example, I am aware of other theories for explaining the pattern of trade, beyond or opposed to the theory of comparative advantage.
  • Lots of minor changes in wording and exposition, most of which I cannot recall offhand.